Renovating Property in your Self Managed Super Fund

This listener question was sent into us by Stephen via our facebook page:

I just listened to the Self Managed Super podcast with Noel and there was some great information in there, but there was one question I have that didn’t come up. What are the concerns so far as ‘donating effort’ to the super fund? For example, if I have a property owned 100% by my SMSF (with or without finance), and I renovate (or maintain) the property myself, with only the cost price of materials paid by the SMSF (i.e. free labour), is that allowable and are there any concerns? Does anyone happen to know?

So, of course, we went straight to the source, Noel, to find out what he had to say – and of course, in his thorough accountant manner, he wrote us an essay! Thanks Noel!

Noel:

One of your listeners has asked whether his SMSF can renovate a property which is held by his SMSF and if so, can he supply his labour for free?

Q. Can I renovate the property in my SMSF?Yes, if you’d rather do that than go to the footy, go sailing, go shopping or go out to lunch, why not get hot and sweaty, stressed and anxious, and create a perfect environment to argue with your partner, go right ahead.

Q. Can I supply my labour for free?
If it were my labour, it would have to be free because nobody would pay for my building skills. But if you are good at it, then there is no reason why you can’t supply your labour for free.

Problems would start to arise if you wanted to charge your superfund for your labour; unless you are a registered builder, qualified at the tasks involved and charging commercial rates for the work. The basic tenet is that no member can benefit from their super fund prior to retirement. It’s only a benefit if you receive more value than the value of what your time was worth. So a commercially based charge for qualified services would be OK.

If it was me, I wouldn’t charge. The superfund would be capitalising the renovation costs resulting in there being with no immediate tax deduction, and possibly only claiming a deduction over 25 years, and even then such a claim would reduce tax at 15%; while you personally would be required to return the charge as income in your own tax return in the current year and you will be charged tax almost certainly at a higher rate than 15%.

Q. Can I charge to maintain my property?
Yes, but the same issues arise. Firstly, the charge must be commercially realistic and be for the same value as the work done. Secondly, the maintenance cost would probably be a tax deduction to the fund in the current year and would save tax at 15%, while the income to you would be taxed at as much as 46.5%. It doesn’t add up.

Q. If I have a limited recourse borrowing on the property, does anything change?Yes, lots of things change.

Labour: You can still supply your labour for free

Maintain & repair: The SMSF can choose to obtain money for maintenance or repair of a property that’s the subject of a limited recourse loan either from existing funds or by borrowing further. Each draw-down of a loan is considered a new borrowing.

Improvement: An improvement is where an assets value is substantially increased through the addition of new or substantially altered features. Improvements are permissible provided that the SMSF a) did not borrow to pay for the improvement, and b) the improvements have not significantly altered the character of the asset resulting in the asset becoming a different asset e.g., demolish and rebuild.

Great care is needed here. Basically you can’t borrow to improve; and even if you use other SMSF funds to improve a property which is the subject of a borrowing, a breach of the rules occurs where the improvements you make changes the character of the property. Put very simply, you should not try to substantially improve a SMSF property which has been funded by a borrowing.

Kaz:

Now when I read that last sentence, I was horrified! What! No renovating a property in your super! Quickly, back to Noel I went with this:

When you said, “Put very simply, you should not try to substantially improve a SMSF property which has been funded by a borrowing”, do you mean only if the funds for improvement are borrowed funds or do you mean you shouldn’t renovate any property in a SMSF at all?

Noel:

Complicated, isn’t it? Actually I don’t mean either of the choices you gave me. If you haven’t borrowed to acquire the property and you will be using ‘other cash assets’ of the fund to renovate – Go for it. If you have borrowed to acquire the property and a) you will be using ‘other cash assets’ of the fund to renovate/improve, NO because the renovation will change the nature of the property; or b) You will be using ‘borrowed funds’ to renovate/improve, No-you can’t borrow to improve.

Kaz:

Wow, ask an accountant a simple question!

Thanks so much, Noel, appreciate the time and effort you spend on helping out the Everyday Property Investing Community!

If you’d like to find out more or maybe even visit Noel to talk finances, you can contact Noel May and Associates for further information.